Treasuries Gain Most in Week as Manufacturing Contracts

July 2 (Bloomberg) -- Yields on Treasury 10- and 30-year
debt declined the most in a week after an industry report showed
U.S. manufacturing unexpectedly contracted in June, spurring
concern the economic recovery is floundering.

Government securities pared losses posted June 29 after
euro-area leaders expanded steps to stem the bloc’s debt crisis,
which damped demand for the safest assets. The Federal Reserve
bought $1.81 billion of U.S. government securities in the first
transaction since policy makers expanded the Operation Twist
program through the end of the year to help cap borrowing costs.

“A recession isn’t going to happen in the next few months,
but clearly the global economy has lost momentum,” said Guy
Haselmann, an interest-rate strategist in New York at Bank of
Nova Scotia, one of the 21 primary dealers that trade with the
Fed. “The risks to Treasuries are for lower yields for the
remainder of the year.”

The benchmark 10-year note yield fell six basis points, or
0.06 percentage point, to 1.59 percent, at 5 p.m. in New York,
according to Bloomberg Bond Trader prices. It earlier declined
as much as nine basis points. The 30-year bond yield slid six
basis points to 2.70 percent after dropping as much as 10 basis
points. The rate climbed eight basis points on June 29.

The 10-year yields fell seven basis points on June 25 while
30-year bond declined nine basis points the same day.

The Institute for Supply Management’s factory index fell to
49.7 in June from 53.5 a month earlier, the Tempe, Arizona-based
group’s report showed. Readings less than 50 signal contraction,
and the median forecast of economists surveyed by Bloomberg News
called for a decline to 52.

As separate data this week is forecast to show employers
added fewer than 100,000 jobs for a third month, another sign
the world’s largest economy is cooling.

Fed Purchases

“It underscores the slowdown domestically as well as
abroad,” said Larry Milstein, managing director in New York of
government- and agency-debt trading at R.W. Pressprich & Co., a
fixed-income broker and dealer for institutional investors. “We
are still being driven by the politics in Europe. We took a step
on Friday, but it was just a small step. The devil is in the
details with Europe more so than in the U.S. You don’t want to
be short Treasuries.”

The Fed purchased as part of Operation Twist Treasuries due
from February 2036 to May 2042 today as investors submitted
$3.588 billion in offers to sell bonds, or 1.98 times the amount
the central bank bought, according to the Fed Bank of New York’s
website.

Investors have scaled back their offers to sell in each
month since March, when they submitted 3.16 times the securities
purchased by the Fed. Submissions fell to 2.92 times in April,
2.82 times in May and 2.48 times in June, Fed data show.

No Change

The central bank last month extended the plan, originally
set to replace $400 billion of shorter-maturity Treasuries in
its holdings with longer-term debt through June, by $267 billion
through the end of 2012.

The difference in yields between 10-year notes and TIPS,
which represents traders’ expectations for the rate of inflation
over the life of the securities and is known as the break-even
rate, was 2.08 percentage points, down from the 2012 high of
2.45 percentage points on March 20. It touched a 2012 low of 1.9
percentage points on Jan. 3.

The EU’s efforts to contain the debt crisis at a summit in
Brussels last week weren’t enough to change Barclays Plc’s view
that U.S. borrowing costs will stay low, the company wrote in a
note to clients.

“We do not expect Friday’s selloff to continue,” Anshul
Pradhan and Vivek Shukla, analysts at Barclays in New York,
wrote in their fixed-income outlook today. “This does not
change our low-for-long rates view.”

‘Further Slowdown’

Gains in Treasuries were tempered amid speculation the
European Central Bank will this week take steps to address the
debt crisis after a report affirmed euro-region manufacturing
contracted for the 11th month in June.

ECB officials will lower their main refinancing rate by 25
basis points to a record low 0.75 percent on July 5, according
to a Bloomberg survey of 57 economists. Five predict a cut of 50
basis points and 12 foresee no change.

European Union leaders agreed at their June 28-29 summit to
loosen bailout rules, lay the foundations for a banking union
and break the link between sovereign and banking debt through
the direct recapitalization of lenders.

“We could see a significant further slowdown in the
economy,” said Larry Dyer, a U.S. interest-rate strategist in
New York with HSBC Holdings Plc, a primary dealer. “There may
be a bit of room for the Fed to go further, but it’s limited in
Treasury space. If they did need to go for another shot, it
would be a case of going to the mortgage market.”

Volatility, Volume

The average rate for a 30-year mortgage has fallen to 3.66
percent from 5.59 percent in June 2009, according to a Freddie
Mac survey.

The gap between the yield on the current coupon Fannie Mae
mortgage security and the Treasury 10-year note has narrowed to
0.92 percentage point from 1.07 percentage points June 1. The
spread has averaged 0.98 percentage point in the past 12 months.

Treasury volatility climbed for the first time in two weeks
following the European announcements, according to Bank of
America Merrill Lynch’s MOVE index. The gauge rose to 73.2 on
June 29 from 70.2 on June 28. The reading has tumbled from 95.4
on June 15, this year’s high.

Treasury Demand

Trading volume jumped. About $280.6 billion of Treasuries
changed hands on June 29 through ICAP Plc, the world’s largest
interdealer broker, the highest level since touching $317
billion on June 20. Volume reached $396 billion on May 31, the
highest level since March. The daily average over the past year
is $251 billion.

Investors are plowing cash into new U.S. Treasuries at a
record pace, making economic growth rather than budget austerity
a key issue as incumbent Barack Obama and Mitt Romney face off
in November’s presidential election.

Bidders offered $3.16 for each dollar of the $1.075
trillion of notes and bonds auctioned by the Treasury Department
this year as yields reached all-time lows, above the previous
high of $3.04 in all of 2011, according to data compiled by
Bloomberg. The so-called bid-to-cover ratio was 2.26 from 1998
to 2001 when the nation ran budget surpluses.

Romney and fellow Republicans have assailed Obama for
presiding over an increase in U.S. publicly owned debt to $10.5
trillion from $5.75 trillion in 2009 amid the worst financial
crisis since the Great Depression. The bond market is showing
growing investor confidence in the safety of dollar assets.

Dollar ‘Haven’

The dollar is a “haven and if you’re going to buy dollars
you’re by and large going to be investing in Treasuries,” James
Kochan, chief fixed-income strategist in Menomonee Falls,
Wisconsin, at Wells Fargo Funds Management LLC, which manages
$232 billion, said in a June 28 telephone interview. “They’re
really one and the same trade.”

U.S. government securities have returned 1.7 percent this
year, compared with a 2.5 percent gain by global government
debt, excluding the U.S., according to Bank of America Merrill
Lynch indexes.